The Cost of Doing Business in the U.S.

My print column this week examines a study commissioned by the Small Business Administration that finds regulation costs American business $1.75 trillion per year, and cost small businesses — those with fewer than 20 workers — $10,585 per employee, or 36% more than paid by large businesses, those with 500 or more.

The study is the latest in a series from SBA on the topic. “Over the years the studies have tried to incorporate potential ways to improve the computation methods and to make them more comprehensive,” said Nicole V. Crain, Lafayette College economist and co-author of the latest SBA study with her husband, Lafayette College economist W. Mark Crain.

The Crains still struggle with a lack of certain key data on costs of regulation. Small businesses’ disproportionate costs for regulation stem primarily from environmental rules, a finding based on data from two decades ago. “At some point, it should become feasible to obtain similar data for more recent years than 1992,” said Thomas Fullerton, an economist at the University of Texas at El Paso who has studied the cost of regulation internationally. “Given the importance of what is being analyzed, that step is practically mandatory.”

“This is the best we have,” Nicole Crain said of the some of the older data used by the study.

The studies generally rely on linking levels of regulation to economic activity. It is possible that there is reverse causality — economic growth drives regulation — or that some other force drives both. “The risk of reverse causality is definitely there and it is one of the things we attempted to control,” Fullerton said.

“Of course this is possible, but not likely,” Nicole Crain said. “Most of the evidence indicates that government regulation — like government programs generally — are ‘normal goods,’ increasing as national incomes rise.”

Tracing regulation over time within countries could help, though it wouldn’t eliminate the possibility of some other factor driving both regulation and economic growth. In any case, the World Bank data on quality of national regulation used by the Crains isn’t old enough for this purpose. “One would hope for at least 20 years for minimal credibility, and 30 years (a sample size of 30) would be the generally accepted period for time-series analysis,” Nicole Crain said.

Other economists say it makes sense that regulation would cost small businesses more, whatever methodological challenges there might be in calculating the scope of that discrepancy. “There is a lot more evidence as well as theory that indicates it’s real,” said John Morrall, who analyzed regulation’s costs for the White House’s Office of Management and Budget and is now an affiliated senior scholar at the Mercatus Center. “Although there are small-business abatement efforts that might counteract the fixed costs of many types of regulation, my 30 years of experience at OMB with the Regulatory Flexibility Act is that agencies spend a lot of time trying to get around it.”

Susan Gates, a senior economist at the think tank RAND Corp., said it is possible society benefits from small businesses having to pay more, per employee, to comply with certain kinds of regulations. If the alternative means “they would be able to do horrible damage to the environment, maybe then it is just not worth it to have smaller firms in this game,” Gates said. “It’s something that needs to be considered.” She pointed to a 2007 RAND report she co-edited that confirmed many earlier studies finding that workplace fatalities are higher at smaller firms within industry sectors, a possible byproduct of exemptions from workplace regulations for small companies.

“Small businesses are among our worst regulation scofflaws,” said Sidney A. Shapiro, university chair in law at Wake Forest University, and a member scholar with the Center for Progressive Reform, which is planning a report evaluating the SBA numbers. “They are often among our most dangerous businesses.”

Frank Ackerman, director of the Climate Economics Group at the Stockholm Environment Institute-U.S. Center at Tufts University an economist at Tufts University’s Global Development and Environment Institute, said environmental regulations’ costs may be worth it, even if small firms can’t afford them. “If they’re going to be handling toxic chemicals in my neighborhood, then it’s absolutely OK with me that they have to bear that regulatory burden,” Ackerman said. “And yes, it’s harder for the smallest companies to afford that level of technical expertise; some companies are too small to do dangerous things with an adequate margin of safety. Having your kids exposed to a toxic chemical spill doesn’t feel any better if it was spilled by a small company.”

The SBA study’s difficulties highlight just how challenging it can be to isolate the effects of regulations from other factors. John W. Dawson, an economist at Appalachian State University, and co-author John Seater of North Carolina State University, estimated that 2008 GDP would be $11.3 trillion higher if not for the opportunity costs imposed by federal regulations. They did so by using the page count of the Code of Federal Regulations as a proxy for the extent of regulation.

The page-count technique “surely has some limitations and shortcomings,” Dawson said, “but it is the best measure I know of that allows for an analysis of trends in regulation over long periods of time.” He added, “Our measure says nothing of the social benefits of regulation.

OMB studies the benefits of certain regulations, and in recent years generally has found they outweigh the costs. “This is a limited sample because independent agencies are not reviewed by OMB nor do they generally estimate costs and benefits,” Morrall cautioned. “It also does not include rules where agencies generally find it difficult to estimate benefits such as Homeland Security nor does it include rules that do not have an impact on the economy of less than $100 million.”

Further reading: Winston Harrington of Resources for the Future criticized the methodology of the SBA’s 2005 study on cost of regulation.

About The Numbers

The Wall Street Journal examines numbers in the news, business and politics. Some numbers are flat-out wrong or biased, while others are valid and help us make informed decisions. We tell the stories behind the stats in occasional updates on this blog.